EUR 850.00 For Business Accounts Only

Morningstar | Tesco's Preliminary Results Reveal EBIT Beat, International Markets Ahead

Tesco, the U.K.’s largest grocer in terms of sales and store network is at the late stages of a turnaround. The firm has been through one of the worst periods in its history, including an accounting scandal in 2014 and a subsequent drop in margins and growth due to the emergence of discounters in the U.K. food retail industry. However, we find Tesco’s turnaround strategy appropriate and feasible, given its leading position in the industry.The company is focused primarily on improving the store experience, introducing new own-store brands (fresh produce) and re-evaluating supplier relationships (smaller base and longer-term partnerships). The turnaround plan is focused on the firm’s traditional strengths: scale in food and well-documented buying power. Early signs are encouraging; Tesco’s ability to better control supplier-related cost inflation, coupled with superior cost saving initiatives, has enabled it to not only offset competitive pressures but also improve margins relative to peers. We surmise that management’s concentrated efforts in transmuting those scale advantages into profitable growth will be successful. Hence, we see the group returning to more normalised profitability levels (though below historical marks), near the lower end of management’s medium-term underlying operating margin target range of 3.5%-4%. Already, the company’s disclosures have shown that the strategy is working, with Tesco outperforming most of its closer peers (Big Four group) in key metrics, such as grocery volumes, like-for-like sales growth, and large-store sales growth. We view that progress as a good first step in the company’s efforts to re-establish its market position. At the same time, Tesco has acquired Booker, the leading U.K. food wholesaler, with a presence in both the retailer (Symbol and Independent) and catering markets. In our view, this aligns with the firm’s long-term plan to further boost scale by consolidating its supplier base and indirectly enhance its food sales through Booker’s overlapping food category efforts.